In the field of product manufacturing, the term assemble-to-order (ATO) refers to systems where products are not produced until the demand for the products becomes known. Manufacture-to-stock (MTS) systems, on the other hand, base production on component availability. Unlike ATO manufacturing, MTS systems often produce products before the demand for those products has been determined.
Manufacturing companies typically prefer to use ATO manufacturing operations whenever possible. ATO allows manufacturers to minimize their component inventories. This reduces the amount of capital invested in components and reduces the risk that components will loose value or become obsolete before they are transformed and sold as products.
In an ATO operation, the availability of components is the key variable that controls the ability to produce. If component availability is limited (either because inventory is limited or because supplier commitments to ship the component on demand are insufficient) then fulfillment of demand either fails or is delayed. On the other hand, if excess inventory is left over, it must be liquidated or utilized later. Both outcomes are costly to the company. If the company liquidates, it may be forced to do so at substantially reduced prices. Many items lose value because of innovation. This is especially true in the especially in the fast moving high-tech sector where goods, such as microprocessor are continually superseded with cheaper more powerful replacements. In other industries there are shelf life considerations that make it costly to try to utilize excess inventory at a later time. In both cases there is capital tied up in extra inventory and that corresponds to incurring a cost equivalent to the firms funding rate.
The cost incurred for component inventory that exceeds the inventory required to meet demand is referred to as the erosion cost. The estimation of erosion costs is paramount in making intelligent business decisions about the proper amount of components to obtain commitments in any given period. This is particularly true when a large number of products are made from a large number of the same components.